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New Zealand could be on the hook for a big bill if it fails to take measures to reduce greenhouse gas emissions or ramp up the supply of carbon credits. Thomas Coughlan asks why we have been slow to increase the domestic supply of carbon credits.

In its briefing to the incoming Minister for Climate Change, James Shaw, the Ministry for the Environment estimated that New Zealand will see between $14-36 billion shaved off its growth forecasts between 2021 and 2030.

The figure is more than double the estimate given to Judith Collins when she became Minister of Energy in December 2016. That briefing estimated the cost at $14.2 billion, but it left off the more drastic model, which projected a much higher cost of $36 billion. To put that in perspective, Treasury has estimated the total cost of rebuilding Christchurch to be $40 billion.

The figure is calculated as a reduction of Real Gross National Disposable Income (RGNDI), a measure of New Zealanders’ wellbeing through their incomes. The two figures relate to two separate models that were used to calculate the RGNDI reduction.

The first, by Landcare, found a 0.5 percent contraction in RGNDI ($14 billion), the second, by Infometrics, calculated a 1.2 percent contraction ($36 billion). Both models were independently assured for quality by NZIER and used by the Government to inform its National Interest Analysis on the Paris Agreement.

The number is even more concerning in light of the Environmental-economic accounts released by Statistics New Zealand last week, which showed that our forestry stock is shrinking at the same time as our gross emissions have risen. Harvested forests are not being replaced and nearly no new forestry stock was planted from 2013 to 2016.

This not only means that a significant portion of the cost of purchasing carbon credits to offset emissions will be sent offshore, it also makes New Zealand highly vulnerable to vast fluctuations in the price of carbon.

In 2013, imported European credits could be purchased for 28 cents per tonne. NZUs (the New Zealand standard) now cost around $21 and modelling shows the price of credits needed from overseas to plug our emissions shortfall could cost as much as $50.

Seeing the wood for the cheese: Does New Zealand’s ETS discourage tree-planting and encourage dairying?

New Zealand has had an emissions trading scheme since 2008. By putting a price on emissions and creating a trading market, the ETS was intended to encourage polluters to pollute less while encouraging foresters to plant trees to sequester more carbon.

Unfortunately, as Statistics NZ’s Environmental-economic accounts showed, since the scheme was introduced, the opposite has happened. Emissions have continued to rise, while forest stocks have been reduced. Some forests have even been cleared for dairy farms.

Where did it all go wrong?

Thomas Song has some idea about the problems with the ETS. He is the Managing Director of Ernslaw One, a company that grows permanent forests for carbon sequestration. Ernslaw One is the fourth largest forest-owner in the country, and each year issues around 1.2 million NZUs.

The company could plant more trees and issue more credits, but key settings in our emissions trading scheme discourage it from doing so.

Until 2015, New Zealand was incredibly exposed to the global price of carbon. When this plummeted following the GFC, so did any incentive to sell credits or plant trees.

“When the price falls below what we think is replaceable price, we simply don’t sell,” Song told Newsroom .

“We just sit on the units. When the price moves within a reasonable range, we tend to try and keep market liquidity going by letting go a bit, but we don’t sell at any price at all. If it’s worthwhile we can hold,” he said.

At the moment, the carbon price is still quite low, giving foresters little incentive to plant, let alone leave trees in place.

“One tonne of logs is equal to two tonnes of carbon,” Song said.

Ernslaw One isn’t alone in feeling the heat. Other companies selling credits have spoken to Newsroom about what they perceive as disincentives to creating a strong domestic carbon credit market.

It’s not just the price of carbon that puts off growers. The Overseas Investment Act means that majority foreign-owned firms like Ernslaw One face regulatory hurdles before they can acquire land to plant on.

Another source told Newsroom that if New Zealand was serious about carbon sequestration, the Government should consider allowing the planting of non-native trees like fast-growing pinus radiata on Department of Conservation land, arguing that native trees grow too slowly to be economical for credits.

But this stance is controversial. Adelia Hallett, Climate Advocate at Forest and Bird, says that the wider benefits to the ecosystem of native planting and pest control is still better for carbon sequestering in the long run.

In the short term, the failure of the ETS will ultimately force the Government to purchase offshore credits it cannot buy from domestic producers.

Designing the ETS

New Zealand’s exposure to international carbon prices is a result of its initial design. Built in the dying days of the previous Labour government, the scheme was designed to lower total emissions without penalising industry.

Unlike many other overseas schemes, we never implemented a true ‘cap and trade’ scheme, one which establishes a ceiling on the total domestic emissions that is progressively lowered over time. Instead, the country nested itself within the international cap established by the Kyoto Protocol.

The scheme allowed participants to buy any number of overseas credits from the Kyoto market. Because demand was relatively small compared to other industrialised countries, businesses could be assured that they would find all the credits they needed on the international market.

In climate terms, this decision allowed us to offset our emissions by encouraging other countries with lower-cost emission reduction opportunities to pollute less. If international credit prices had risen in line with expectations, then emitters would have faced a growing incentive to reduce their own emissions.

Catherine Leining, Policy Fellow at Motu, was a member of the group that developed the initial ETS and told Newsroom that the ETS’s architects were worried about the impact of the price of credits rising.

“Ours was the only system in the world that had unlimited access to international carbon units,” Leining said.

“And at the time we created the ETS we were expecting global emissions prices to rise. We were more worried about the upside price risk; we weren’t thinking about the downside price risk,” she said.

In 2009, the new government moved further to limit upside risk by halving the unit obligation for non-forestry sectors and introducing a price ceiling: participants had an option to meet their obligations by buying units at a fixed price of $25 per tonne.

When the GFC hit global industrial output, the Kyoto market was flooded with cheap carbon credits, including ‘hot air’ credits from countries like Russia and Ukraine. New Zealand, with unlimited ETS linkages, was highly exposed. Domestic emission prices crashed so low that there was almost no incentive to invest in tree planting for carbon sequestration.

The decision taken by the government in 2012 to take its next targets under the UN Framework convention on Climate Change rather than the Kyoto protocol has inadvertently aided the recovery of NZUs. To purchase carbon credits on the international market, countries must be signed up to Kyoto targets. Not signing up to the second round of Kyoto targets had the effect of locking New Zealand out of the international carbon credit market. This also had the effect of ending the sale of dubious "hot air" credits from Ukraine and Russia here.

The price of NZUs delinked from international Kyoto-linked units and headed towards $21, where it sits now. New Zealand’s ETS is now a domestic market. Domestic emitters must purchase domestic credits. At the moment, this serves to keep prices relatively high.

Splitting the bill

Now New Zealand has taken a steeper emission reduction target for 2021-2030 under the Paris Agreement, and we face a significant target gap between our projected and targeted emissions. The ETS only accounts for some of our emissions, other emissions (including the significant emissions of livestock) are still outside the scheme. These sectors will have to reduce emissions to within the target. In the event that they do not, there will be a significant cost in purchasing credits to offset the emissions.

The cost won’t just be borne by the economy and Kiwis’ disposable income. The Government will pick up a significant portion of the tab by purchasing international credits to cover this gap. This is not necessarily a bad thing.

“Placing all of New Zealand’s emission reduction burden on the present ETS sectors would not be feasible or fair for many reasons,” said Leining.

“Over time, all sectors of the economy will need to contribute to New Zealand’s net zero transition, whether they are inside or outside of the ETS. While higher emission prices will help, additional policies will also be needed,” she said.

For the ETS to achieve carbon neutrality, it would need to accomplish the nearly impossible task of reducing emissions from included industries so low they accommodated for the emissions of industries not included.

As this is unlikely, the Government is obliged to purchase international credits to compensate for the gap between our actual emissions and our international targets. These credits will be sold by countries who have met and then exceeded their targets and have surplus credits to sell. At the moment, we are on track to miss our targets by quite a margin, making us heavily reliant on overseas credits.

A Regulatory Impact Statement from the Ministry for the Environment calculated that the Government may have to purchase 150 million international units over the 2021-2030 period to meet our Paris commitment. This would cost between $3.5-7.5 billion cumulatively over the 2021-2030 period, assuming an international carbon price of $25-50 per tonne.

But this could be just the tip of the iceberg. Other countries struggling to meet their targets will be reliant on international credits as well. With so few on the market and so many countries after them, the law of supply and demand suggests New Zealand’s liability may be very costly indeed — possibly far in excess of the $50 modelled by the Ministry. The same Regulatory Impact Statement concedes the potential fiscal risk of the unit deficit depends on carbon prices in the 2020s, which cannot be known.

The country's heavy reliance on international credits makes us heavily exposed to one of the world’s most potentially volatile markets. Unless the rest of the world’s polluters make a far better effort than us to reduce their carbon footprints, we could find ourselves facing a very large bill for emissions mitigation.